What Kind of Stocks Fragment the Most?

Overview

As most people reading this article will know, the percentage of trading volume
on the main market LSE for FTSE-100 stocks is currently hovering at around 60%.
So about 40% of the volume in these stocks is executed on the other lit MTF venues.

However, within the 102 stocks of the FTSE-100 index, how much does the level of
fragmentation differ for individual stocks? Assuming there are significant differences
in market shares for LSE for different stocks in the index (there are), a more intriguing
question is what 'kind' of stocks might the MTF venues have gained most market share
in?

For instance, does the LSE or Euronext do relatively better or worse (in market
share terms) with stocks that have higher or lower tick sizes relative to their
spreads(strictly speaking 'spread leeways'). Have a guess now and check your answer
later in this article.

Aside from the simple market share the primary venue retains, one can also pose
MTF venue specific questions such as:

Does CHIX do better or worse on stocks with higher/lower intraday price volatility?

Does TRQX do better or worse with stocks with a higher/lower level of total European
trading volume?

Does BATS do better or worse on stocks with a higher/lower tick sizes?

Bringing all of this together, can we build a profile of the kinds of stocks that
seem most prone to high degrees of fragmentation? Also can we say what types of
stocks the different current venues seem to do best in from a market share point
of view?

Knowing answers to these questions not only helps explain the current spread of
market shares in different instruments, it may also provide some insight into what
might happen to fragmentation if, for instance, market conditions (trading volumes
/volatility) or microstructure rules (tick sizes) were to alter in the future.

Indices Covered

It would be nice to do this analysis for all European market indices; however, that
would make for a rather long article! So we will focus primarily on the UK FTSE-100
index, which is the index which currently shows the highest degree of fragmentation.
We will also, however show results from other indices (AEX, MIB, FTSE-250) at various
points.

To get a rough idea of the current state of fragmentation of the FTSE-100 index,
below is a LiquidMetrix Battlemap for the Week of 8th February 2010. The
Battlemap summarises market shares, spreads, book depths and 'best price' availability
for the FTSE-100 index on the different venues.

(click the image to enlarge)

At a high level:

LSE has around 58% market share, CHIX around 27% etc.

CHIX and LSE are closely matched in terms of spreads, book depths and 'Best Price'
percentages for smaller orders 'At Touch'

Now let's start drilling inside the FTSE-100 index and see what is happening on
an instrument by instrument level.

Basic Breakdown of Market Shares Stock by Stock

FTSE-100 The graph below shows relative market shares (y-axis) for
each of the 102 instruments in the FTSE-100 index shown in an arbitrary order along
the x-axis. The coloured bars show the market shares for each venue.

The Average value of 60% market share for the LSE translates into a range of
50-80% at the stock by stock level.

The MTFs also have quite significant stock by stock ranges, for instance, market
shares for instruments on BATS vary from about 2% (Schroeders) to 15% (RSA).

The data shown in this chart is averaged for the whole of January 2010. However,
a similar chart for December 2009 shows that whilst there is a similar range of
values, the market share for individual instruments does not vary greatly month
to month. So for instance, the stock 'RSA' has had a lower than average (i.e. below
60%) LSE market share consistently week on week for a long period of time. There
is something specific to this stock that is leading to a higher degree of fragmentation
from the primary venue than other stocks in the index.

AEX
The same graph for the AEX (below) shows a similar story (albeit at a lower level
of fragmentation). Euronext's market shares range from 62% to 85% and CHIX,
for instance, has a range of 10-24% market share in individual instruments.

(click the image to enlarge)

So the question is why might different stocks have different degrees of fragmentation?
To answer this we will try looking at how the market share of different stocks correlates
with different characteristics of the trading activity of that stock such as total
value traded, price volatility and spread leeway. We will start with total trading
activity.

Breakdown By Total Trading Activity.

Our first attempt to explain stock by stork market share difference will be to order
the instruments in the FTSE-100 by total value traded across all venues. So for
the FTSE-100 this puts Rio Tinto as the first stock in the list, trading an average
of around £320m per day and Alliance Trust as the last stock, trading an average
of around £1.5m per day.

(click the image to enlarge)

This picture gives a good overview but is a little hard to read, so the table below
shows summaries of market share for each quartile of stocks. i.e. the first quartile
averages market shares for the 27 most actively traded stocks, then the next 26
etc.

(click the image to enlarge)

From this we can see

LSE has a higher market share in the less actively traded stocks (62.92%).

CHIX and BATS behave in the opposite way, i.e. they have higher shares in the more
actively traded stocks.

Interestingly, TRQX behaves similarly to the LSE i.e. it has more market
share in the less heavily traded stocks. NURO also, if anything, does slightly better
on the less actively traded stocks

A similar picture emerges when looking at the AEX index, the trends for Euronext,
CHIX and BATS are if anything stronger than for the FTSE-100.

(click the image to enlarge)

Breakdown By Intraday Volatility

Next, we will try ordering the stocks based on their intraday 1-minute price volatility.
This is the standard deviation of minutely mid price 'returns' on the primary venue
expressed in basis points. Using volatility the instruments are ordered from the
most volatile, Royal Bank of Scotland with a volatility of 15 BPS/minute to Reckitt
Benckiser with 1.6 BPS/min.

(click the image to enlarge)

(click the image to enlarge)

This time there is no clear up/down trend in market shares. LSE does perhaps slightly
better on the two extremes, i.e. for the most and least volatile stocks,
but looking at all the instruments individually the market shares seem fairly randomly
distributed. So, price volatility does not appear to be a good predictor of market
share / fragmentation.

Breakdown by Spread Leeway

Spread leeway is a measure of the size of the smallest price increment (tick) of
a stock compared with its average quoted bid/offer spread. As an example,
if the tick size of a UK stock is 0.05p and its average spread is 0.125p then the
spread leeway would be (0.125/0.05) - 1 = 1.5. Possible values range from
0, where the bid and offer spread of the market is always exactly one tick wide
to in theory any value, though values above 10 for liquid stocks are rare.

A small spread leeway indicates it will be more difficult for a potential liquidity
provider to post a new better bid or offer price inside the current best bid/offer
prices. In other words there is less 'leeway' for a market maker or other liquidity
provider to improve the existing best bid/offer price. It also means, in a fragmented
market, it will be more common for there to be more than one venue offering the
best European Bid or Offer price at the same time.

Prior to the tick size changes in the summer of 2009, spread leeways in European
markets tended to be rather low. Since the summer spread leeways in some of the
more liquid instruments have increased as smaller tick sizes were introduced.

BATS and Deutsche Bourse have expressed the opinion (http://www.batstrading.co.uk/resources/participant_resources/BATSEuro_Tick_Size_Paper.pdf)
that the best ranges for spread leeway are around 3-10 [BATS ] or 5-19 [Deutsche
Bourse]. Most stocks in the major European indices tend to have somewhat
lower spread leeways than this.

As an illustration of what spread leeway means in practice, below we show two CHIX
order books from FTSE 100 stocks, Liberty (on the left) has a fairly high spread
leeway (3.64) and one can see small numbers of orders at each price level
and a choice market (i.e. 'empty' price slots between best bid and offer). Diageo
on the other hand has a low spread leeway (0.12) and one can see there are
many orders at each price level and the best bid and offer are separated by a single
tick.

Liberty OrderBook (high spread leeway)
(click the image to enlarge)

Diageo OrderBook (low spread leeway)
(click the image to enlarge)

So, if we look at the market shares of stocks in the FTSE-100 ordering the stocks
by spread leeway, we get the chart below.

(click the image to enlarge)

What we see is:

LSE does considerably better on stocks with a higher spread leeway, its market
share rises from 57% to 63% as leeway increases.

CHIX and TRQX do slightly better on stocks with lower spread leeway.

BATS does much better on stocks with a low spread leeway. Market share almost
doubles from the top to bottom percentiles. BATS shows this strong preference for
low spread leeway across a number of indices including AEX (shown below, where for
instance BATS has 4.49% market share for stocks with the lowest spread leeway),
MIB and CAC.

(click the image to enlarge)

Conclusion

The main conclusions of this short study are:

Within indices different stocks have different levels of
fragmentation that are fairly persistent over time. It seems that some venues do
consistently better on certain stocks.

Generally speaking there is most fragmentation (volume
traded away from the main venue) for stocks with:

High Daily Value Traded

Low spread leeway.

Differing price volatilities show little effect on the
degree of fragmentation.

In addition to these general rules there are some interesting venue specific behaviours
for instance:

On UK stocks TRQX's and NURO's market share actually show
the same pattern as the primary (LSE) in terms of market share versus value traded
i.e. they have higher market share for instruments with lower overall trading activity.
But their fellow MTFs, CHIX and BATS behave in the opposite way.

BATS does extremely well on stocks with low spread leeways.

For the FTSE-100 we can summarise the behaviour of different venues in the table
below:

High Daily Trading Volume

High Price Volatility

High Spread Leeway

LSE

-

n/a

++

CHIX

+

n/a

-

BATS

+

n/a

--

TRQX

-

n/a

-

NURO

-

n/a

+

Here we show what aspects of a stock tend to make a particular venue have a much
higher(++), higher(+), lower(-) or much lower (--) market share.

Caveats and other Points

This is not a rigorous analysis. In particular, the patterns we have found
are correlations not causations! For instance, it could be argued that more fragmentation
leads to tighter spreads which leads to lower spread leeways. Alternatively, it
could be suggested that a low spread leeway means that the depth/price advantages
for the primary venues are neutralised, as there are lots of bids and offers just
one tick apart and all that is left to compete on in terms of which venue to trade
on is the exchange fee and so the MTFs have an advantage here that leads to more
fragmentation. Our data could support either argument!

What we can say is that low spread leeways certainly correlate with higher fragmentation,
which is not necessarily what many people might guess at first, especially as the
drive to lower tick sizes (and hence raise spread leeways) over the summer was initiated
largely by the actions of the MTFs.

Our main analysis has focussed on the more liquid stocks in the major indices. It's
interesting to look further down the list of stocks quoted on MTFs. For instance
the graphs below show the FTSE-250 stocks ordered by Daily Trading Volume (top) and
Spread Leeway (bottom). This shows the extent to which fragmentation drops
off as we reach stocks that are less actively traded and/or have high spread leeways.

(click the image to enlarge)

(click the image to enlarge)

It will be interesting to see if in the coming months any further significant fragmentation
can happen in these 'smaller' stocks currently mainly traded on the primary
market. Whether or not it is possible for the MTFs to capture market share in lower
value traded/high(er) spread leeway stocks will determine to what extent market
share fragmentation in Europe will remain limited to the few hundred most liquid
stocks.

If you have any comments / suggestions about this article and in particular if you
think we have got anything wrong please let us know! You can contact us at
liquidmetrix@if5.com

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